PetSmart Falls 9%

By Sam Mamudi

Shares of PetSmart (PETM) are down about 9% this afternoon…with not much news other than a (admittedly very negative) downgrade of the stock by Nomura analyst Aram Rubinson.

In a note this morning, Rubinson downgraded PetSmart, which he’d rated as a Buy until last summer, as a Sell, and cut his target price for the stock to $55 from $72. What caused such a dramatic reconsideration?:

[The price cut] anticipates multiple compression and lower estimates due to ecommerce concerns, senior management change and margins that have reached a plateau. In the past, we have downplayed the threat of ecommerce to PETM since shipping bulky food is inherently unprofitable. But a new analysis suggests pet food isn’t very profitable in the physical world either.

Ouch.

PetSmart’s had an outstanding run in recent years, climbing 45% in 2009, 49% in 2010, 29% in 2011 and 33% last year. Some of today’s move could be that investors were just waiting to cash out, and Rubinson’s note gave them a good reason.

In particular, the analyst is worried about competition from online retailers, notably Amazon (AMZN), especially as the latter’s shipping costs (important for bulky pet food) decline. He also notes with concern the departure of CEO Bob Moran and CFO Chip Molloy:

[Molloy's November] announcement caused us some consternation. Last week’s announcement that CEO Moran is stepping down is also unsettling. We believe David Lenhardt – PETM’s CEO to-be – will carry the torch smartly, but the timing of executive departures is always worth noting.

Rubinson’s call is so far an isolated one: PetSmart is a consensus Buy on Wall Street, according to FactSet, and has a mean target price of $74.18, more than $10 above today’s price. The company’s price-to-earnings ratio based on the next 12 months earnings forecast is 16.2, even at today’s trading price — still above its five-year average of 15.9; its enterprise value to EBITDA ratio is just over 8, which Rubinson considers rich:

On the one hand, PETM should fare much better than the 4x fate ascribed to retailers with an imminent online threat. On the other hand, we do not think PETM should enjoy the same 8x multiple accorded to what we believe are more ecommerce-proof businesses like Dollar Stores and Auto Parts. For now, Bed Bath & Beyond (BBBY) could be a good proxy for market sentiment. We use a 6x target multiple to value BBBY. We are now doing the same to value PETM.

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